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MALUALKON, South Sudan (Reuters) - The world's newest nation relies on oil to finance 98 percent of its budget. So when the government decided to shut off crude production in January after a dispute with a neighbor, South Sudan's foreign donors and aid groups were shocked.

How will the country survive, they wondered?

By leaning even more heavily on donors and aid groups, an examination of the country's safety net shows.

As in many developing nations, international aid is both an invaluable help to South Sudan and a crutch that sometimes enables it to avoid reality. Development experts have grown more sophisticated in recent decades about how they deliver aid. But in fragile states such as South Sudan, getting the balance right between helping a country and helping that country help itself remains incredibly difficult.

On paper, South Sudanese are actually better off than their neighbors. When the oil was flowing, the government estimated per capita GDP at more than $1,500, double that in Kenya and triple that in Uganda. The government's annual budget in 2011 was $2.3 billion.

But decades of war and neglect have left South Sudan dirt poor. That's why foreign governments and other donors gave just under $1 billion or so in aid in 2010, the latest available figures. None of that money went directly to South Sudan's government. But it funded everything from security training to food, drugs, textbooks and a host of other services. Around four-fifths of all health care is provided by outside groups.

South Sudan's President Salva Kiir has spoken a number of times of his country's reliance on aid. "We still depend on others. Our liberty today is incomplete," he said at an independence day speech yesterday. "We must be more than liberated. We have to be independent economically."

In a series of stories that chronicle South Sudan's first year of independence, Reuters is examining the country's chances of success. Getting the aid calculus right is one of the biggest challenges.

As it celebrates its birth, South Sudan faces an economic crisis. Without oil, the country is quickly running out of money. Ministries that should be taking on more and more responsibility for running things are instead cutting their budgets. The World Bank has warned of the "real possibility" of "state collapse."

Many donors are furious with the oil shutdown and say they won't pony up more money. But even before the government's decision, a series of emergencies - ethnic violence, food shortages, an unexpected influx of refugees - had pushed donors to shift money earmarked for long-term development plans back into things like food aid and emergency shelter.

Last week the United Nations increased the amount of funding it thinks South Sudan will need in 2012 from $763 million to $1.15 billion. That money will assist the country through a lean period, but has delayed efforts to help the government help itself.

Hilde Johnson, the U.N. Secretary General's Special Representative for South Sudan, said the government is still weak and struggling to take on more. The broad effort by the U.N. and aid groups to transfer responsibilities to the state "is just not happening," she said. "This is one of the things that the aid community is struggling with."

A SUSPECTED CASE OF TETANUS

Nowhere is South Sudan's dependence on the outside world more clear than in its health system.

One Sunday afternoon early last month, a white Toyota Land Cruiser pulled into the compound of a health-care center in the state of Northern Bahr el Ghazal, near the border with Sudan. In the back of the vehicle, a mother hugged her week-old baby, who had a suspected case of neo-natal tetanus.

James Majuong Macar, the clinical officer at the center, helped load two more patients into the makeshift ambulance: a 12-year-old boy with a fractured leg that had ballooned alarmingly, and a three-month-old girl whom Macar thought probably had meningitis.

A storm was moving in. Wind whipped through a huge fig tree and a bicycle fell to the ground with a rattle. The Land Cruiser turned out of the gate to make the hour-long drive through the rain south to Aweil, the state capital.

The people of South Sudan face cholera, measles, meningitis, polio, river blindness, sleeping sickness, yellow fever and whooping cough. Malaria accounts for a quarter of all hospital visits. South Sudan has one of the highest maternal mortality rates in the world. Around one in six children die within their first year.

And there are just 120 doctors and 100 nurses in a country of 8 million.

"The health system as it is now, is extraordinarily dependent on non-governmental actors," said Susan Purdin, the head of U.S.-based aid group International Rescue Committee in South Sudan. "Many years and much money, used prudently, will be needed to transition from what it is to what is envisioned."

The Ministry of Finance and Economic Planning calculates that the country received almost $179 million in aid for health in 2010, the second-biggest amount after funding for social and humanitarian affairs, which includes things like food aid and emergency medicines.

"HONOUR AND INTEGRITY"

South Sudan depended on aid long before it became a country.

During the south's decades-long civil war with Khartoum, the capital of Sudan, aid groups and donors kept health clinics running and built a massive hospital over the border in Kenya to treat South Sudanese who were ill or wounded by the fighting. The United Nations and aid groups helped feed people when the crops failed, and kept schools open. But aid certainly did not reach everyone.

In the lead-up to independence and in the 12 months since, many more aid groups have arrived. Donors have spent billions to build roads and bore wells, ferret out mines laid during the civil war, print textbooks, train women to farm, audit state finances and help the government write laws. They have hung more than 1 million bed nets to protect children from malarial mosquitoes and supplied sewage trucks to the prison headquarters.

In short, they have begun the effort to move from delivering emergency aid to longer-term development. But the emergencies and the oil shutdown have started to send that progress into reverse - stoking tension between the new government and some donors.

The country exports its crude through a pipeline that crosses Sudan. Juba believes the government in Khartoum stole 1.7 million barrels of oil from the pipe. Khartoum said it confiscated what it was owed in pipeline transit fees. When the two sides could not reach a settlement, South Sudan decided it would rather go without oil revenue than allow its enemy to have any.

In defending their decision to cut off the oil, South Sudanese officials have told western diplomats that "the independence, honor and integrity of South Sudan is more important than material things," according to one European diplomat.

RISK OF "COLLAPSE"

But the economic implications are dire. A World Bank memo on the country's outlook paints a dramatic picture. The memo, written in March and leaked to a local newspaper in May, said that the oil shutoff threatened the state's survival.

"The World Bank has never seen a situation as dramatic as the one faced by South Sudan," it read. "The shutdown will lead to a rapid reversal in key development gains." The Bank forecast that the number of people living in poverty will likely jump from 51 percent to 83 percent by 2013, that the mortality rate for children under 5 will double, and that the percentage of children attending primary school will drop to 20 percent from 50 percent today.

"Donors have been asked to help cover the gap by supporting basic services," the report said. "They are increasingly unwilling to do this or support any other aspect of the government's aid strategy."

The World Bank issued a statement after the document was published. It said it had "recently provided an assessment of the economic situation as requested by the Government of South Sudan" but that press coverage had misrepresented "the nature and content of the dialogue" between the Bank and the government and donors.

The South Sudanese have expressed their own frustration. When U.N. Secretary General Ban-Ki Moon urged Juba to withdraw its troops from a disputed area of the border with Sudan in April, President Kiir told South Sudan's parliament that he had told Ban: "I'm not under your command."

A United Nations spokesman said Ban had contacted both South Sudan's president and Sudan's U.N. ambassador and told them "peace and dialogue is the only option."

Kevin J. Mullally, country director of the United States Agency for International Development, by far the single biggest donor, said Juba's oil decision means at least some long-term development plans will have to be put on hold. "We're a planning agency trying to divine the future," he lamented.

A HOSPITAL

One thing he can plan on is the health system relying on foreign aid for years to come.

The Malualkon primary health care center, where the Land Cruiser picked up its patients, is officially a government facility. But it is supported by the International Rescue Committee, which has worked in southern Sudan for more than 20 years and has projects in health, education and other areas.

The IRC pays Macar's wages and those of other health workers, both in Malualkon and across the country. The agency has trained women to become birth attendants and taught people in remote villages how to dispense drugs to treat illnesses such as malaria and diarrhea.

The IRC also runs the ambulance that collects sick people from their villages and ferries them to the health center or to Aweil, home to the only hospital in Northern Bahr el Ghazal.

The hospital itself is divided between government-run wards (outpatient, male inpatient) and those run by the international aid group Doctors Without Borders (pediatric, maternity). The U.N. and an alphabet soup of non-governmental groups, including the IRC, also offer support.

Dr. Garang Thomas Dhel, the 38-year-old director of the hospital, is frank about the limits of the care the state can provide. Dhel has only 158 employees, compared to more than 250 who work in the wards run by Doctors Without Borders.

Since secession, hundreds of thousands of South Sudanese have returned home from Khartoum. As a result, the number of patients the hospital treats every month has tripled to around 6,000.

"The staff are not enough, and even the available staff are not that well trained," Dhel said.

Bringing in more doctors and nurses is out of the question. The Ministry of Health has imposed a hiring freeze. Even before the oil money stopped flowing, the hospital essentially ran without an operating budget. A few months ago it imposed a fee of two pounds ($0.50) when a patient needed a laboratory test to help it with running costs.

Things have improved since the end of the war, Dhel said, but he hated to think how the hospital would run in the absence of Doctors Without Borders.

"If they terminate their mission it would be a catastrophe," he said.

"A VERY BIG SUPPLY OF NOTHING"

Dhel's biggest complaint - one repeated by almost everyone involved in health care - is the erratic supply of drugs and other supplies.

The drug-distribution system was set up about 6 years ago. A group of big donors - including Canada, the European Union, Germany, Italy and Britain - pooled most of their aid. They asked the World Bank to administer a fund and work with South Sudan's government to construct roads and bridges, improve education and health care, and build up Juba's ability to run things.

Among the fund's tasks is financing drug purchases. The World Bank helped the government procure medicines on the global market; Juba then hired a private contractor to distribute the drugs around the country. Hospitals and health centers were meant to receive new supplies four times a year.

But South Sudanese doctors and aid groups say deliveries have often taken much longer. When a shipment does turn up at his hospital, Dhel said, it is often not the life-saving anti-malarials, antibiotics and intravenous equipment he needs, but boxes of basic pain killers.

"It is a very big supply of nothing," he said.

The South Sudanese and the World Bank disagree over the cause of these failings.

One of the problems, South Sudanese doctors and some aid workers say, is that the system was set up using a "push model": The central government decides what drugs and supplies to send out, without giving individual hospitals a say in what they need.

South Sudan's deputy health minister, Dr. Yatta Lori Lugor, said the system doesn't work, and the World Bank should take responsibility for that.

"It was not the Ministry of Health that decided, it was the World Bank," he said, sitting at his desk in the modest, two-story Ministry of Health building. "It was a mistake."

But Bella Bird, the South Sudan country director at the World Bank, said the decision to use the system was taken by a committee that included the donors and the government of South Sudan.

"We knew it wasn't a long term solution," she said. "There are real teething problems getting things going in a country which pretty much had nothing. It can take years. And we have to chip away at it slowly."

A U.N. official in Juba said the system was deliberately kept simple because the government lacked the capacity to handle anything more complicated.

Transport problems, bureaucratic bungling and civil unrest in some regions mean drug shipments are regularly held up for weeks, often sitting in shipping containers in the scorching sun. The official said the state of Jonglei had been waiting since June last year for a new shipment. Aid groups have had to step in and supply emergency drugs in some states, in one case to halt a surge in malaria deaths.

The drug-procurement contracts ended in June. Deputy Health Minister Lugor said the ministry wants to replace it with something that worked.

"We understand South Sudan better," he said. Foreign aid groups and international organizations sometimes arrive with "assumptions that are maybe not right. Maybe they think they know better."

But asked whether the country needed their aid, he looked stunned.

"Wow!" he said. "Of course… Until that time when we can run things ourselves, we need them."

Wasn't there a danger that too much aid would make South Sudan dependent?

"Dependency is when you don't want to do something," Lugor said. South Sudan may be struggling to train its own civil servants and take on responsibilities, but it wants to run its own affairs eventually, he said.

"There is no dependency here."

(Edited by Michael Williams)

(This is the second article in a series, "Birthing a Nation - South Sudan's first year")